Bottom-up Financial Reform

The financial reform bill recently signed by President Obama will attempt to attack numerous regulatory gaps and enforce new consumer protections to prevent the next global economic crisis.

But consider this thought from historian Niall Ferguson in his book "The Ascent of Money" (which, by the way, was written before the worst of the financial crisis hit):

"Politicians, central bankers and businessmen regularly lament the extent of public ignorance about money, and with good reason. A society that expects most individuals to take responsibility for the management of their own expenditure and income after tax, that expects most adults to own their own homes and that leaves it to the individual to determine how much to save for retirement and whether or not to take out health insurance, is surely storing up trouble for the future by leaving its citizens so ill-equipped to make wise financial decisions."

The financial institutions who duped unassuming home buyers into taking on mortgages they couldn't afford and the regulators who failed to identify the risks of doing so are certainly to share the blame for the recent economic turmoil. But a major missing piece in the recent regulatory reform bill, and in the general conversation about righting the economy, is an effort to improve basic financial and economics education - something that should be part of every primary high school and college curriculum. For most Americans, this education once came in the home, with parents teaching children about saving money, living within one's means, earning before spending.

But the expansion of credit over the last two generations has complicated this message: Spend, so long as you can pay the interest. Living beyond one's means is now possible - indeed a miracle of credit - but has created a sort of financial overconfidence in society.

In the principal-agent failure that took place in the recent crisis, the "principals" (bankers, etc.) with access and financial sophistication far above that of the average person were able to manipulate finance to make enormous profits, all the while knowingly risking stability of the financial system that enabled such tactics.

The new reforms notwithstanding, it is difficult to assume these mistakes won't happen again when the "agents" in society, ranging from local police pensions funds to average Joes, continue to be ignorant of the rapidly evolving world of finance.

The Dangers of Austerity

If the recent Group of 20 summit is any indication, a reprise of the mistake of the 1930's may soon be on the horizon.

An interesting article in The New York Times details how governments worldwide are under pressure to begin scaling back their stimulus measures implemented in late 2008/early 2009 as a response to the global financial crisis. A rhetoric of austerity is the new modus operandi among governments who increasingly feel the political pinch from large budget deficits. The major economies in the 1920's and 1930's also attempted the same thing, thinking such a strategy of austerity would remove the ills of an overheating, inflation-bound economy, but with disastrous results.

The decision in the 1930's to deflate was borne out of a stubborn bias among the world's major central banks of the time - those of the United States, England, Germany and France - toward the international gold standard, which required countries during economic downturns with high inflation prospects to reduce aggregate demand, and therefore prices (wages) and stabilize trade flows, thereby stimulating gold inflows and bringing trade flows back into balance. It is widely believed by scholars, including current Federal Reserve Chairman Ben Bernanke, that this bias by central bankers toward the gold standard during the economic crash in the 1920's and 1930's inadvertently accelerated the descent into Depression because unemployment exploded and the banking system of the time could not handle the stresses of such economic uncertainty.

A major reason why central bankers held such a view was the relative political strength of Wall Street and other financial political-economic machines at the time. The 1920's spelled the official rise of New York as an international financial center, and helped catalyze a shift of political weight from Washington and the farmers to New York. This growing class of financial elite demanded government economic policies that were staunch against inflation, because deflation favors people with assets (bankers and other elite) and disfavors those with liabilities (everyone else).

Today, however, it is unclear whether the financial elite hold as much relative political power. It is therefore doubtful that governments, at least the U.S. government at that, will actually follow through on promises to impose austerity measures. Only in those countries where the financial or industrial sectors hold greater political power (the United Kingdom, for example), will governments actually implement real austerity measures - or at least create the political illusion of it. Indeed, the UK's coalition government proposed an austerity budget that could create drastic cuts in government ministries. Though each country has its own reasons for and against imposing austerity measures, such measures at a time of continuing economic weakness around the world could be disastrous and undo any of the progress made in the last year.

Banking on Europe - the ECB's Uncharted Waters

Just in time for the 50th post of this less-than-illustrious blog, the Greek debt crisis reaches a fever pitch and her European neighbors step in to save the day.

Late Sunday various leaders and finance ministers in the European Union and Eurozone as well as the International Monetary Fund announced the creation of an almost $1 billion fund to aid indebted countries in Europe, calming markets and soothing nervous politicians - especially German Chancellor Angela Merkel, whose delicate tightrope walk in leading Europe through troubled economic times has already cost her party in the polls in a recent regional election.

In the elastic thinker's view, while this move was a necessity in the short run to sustain the euro currency zone and calm market fears, it undermined a major institutional strength of the European Union: its autonomy on matters of regional economic policy.

The European Central Bank is widely praised as one of the world's most independent central banks, conducting monetary policy strictly on a singular objective of keeping inflation close to a target range and harmonizing economic growth throughout the currency zone with zero regard for political pressures in individual countries to keep interest rates high or low or to finance government debt. As a result of its independence, it cannot serve as a lender of last resort to Eurozone members like Greece that forgo their responsibilities to keep public spending and debt, and ultimately inflation, under certain levels to prevent a misalignment in the exchange rate parities that keep the European Exchange Rate Mechanism functional.

Instead, with the creation of this fund, albeit necessary, Europe has decided to make the ECB more of an activist monetary authority without explicitly calling it that. By creating a separate "fund," there will be an appearance that a separate body, not the ECB, will be stepping in and rewarding bad behavior by bailing out profligate spenders in the eurozone - when in fact the ECB has already started purchasing bonds to inject money into the banking system. It may continue to be statutorily independent, however it will undoubtedly have no choice but to support any move to bail out countries because such bailouts will ultimately have monetary implications that will influence future interest-rate policy.

By sacrificing the ECB's independence in the short run, the European authorities have mortgaged away the biggest strength of its currency. This will hurt the value of the euro in the long run and undermine the currency's prospect of rivaling the U.S. dollar as the world's reserve currency.

It will be interesting to see how these uncharted waters for the ECB and other EU economic policy-making bodies will evolve during this key test of Europe's institutional unity.

Financial System Reform in the U.S.: What Happens Next

Columbia University's Committee on Global Thought yesterday hosted a lecture with two movers-and-shakers, past and present, in the world of financial regulation in the United States: former Securities and Exchange Commission Chairman Arthur Levitt, and current Commodity Futures Trading Commission chief Gary Gensler. The topic: how to reform a regulatory system that fell asleep at the wheel and failed to detect a crisis.

The panel discussion - chaired by Nobel laureate Joseph Stiglitz - came to two key conclusions: financial markets need more transparency, and the United States needs to take the lead in developing smart regulations if the rest of the world is to sign on.

Gensler's proposal is to bring more futures/derivatives trading into a central clearinghouse, allowing regulators to more easily monitor and assess risk in a market that is fragmented. Centralizing derivatives transactions into a more open, central clearinghouse will cut into the premiums earned by derivatives dealers but will also make the market less risky and more transparent, he contends.

Levitt, a veteran of the Clinton Administration, was decidedly pessimistic on the financial reforms proposed both in the U.S. House and Senate, saying they would do little to prevent moral hazard and a "too big to fail" mentality among major financial institutions. He also said Europe, the United Kingdom and other major financial centers will fail to tighten their regulations until the United States takes the lead. Gensler agreed, but admitted that after 18 years on Wall Street, he knows bankers will, in such a case, take advantage of the inevitable opportunity for regulatory arbitrage - that is, investors will put their money in jurisdictions where capital is less tightly regulated at the expense of American financial markets. These points illustrate that any kind of real policy coordination between the United States and the European Economic Community is an idealistic, rather than realistic, endeavor in such tight political and economic conditions.

What the panel failed to accomplish was finding a way to navigate through the alphabet soup of agencies that are already charged with regulating various segments of the American financial system. Very little was said about the Federal Reserve System, which despite being charged with regulating the banking system from a macroeconomic view, is widely criticized for failing to regulate and for creating the conditions that enabled the crisis through its loose monetary policy. And yet, the Fed remains a key player in any regulatory structure going forward and needs to be a keystone of any reform.

In the end, the discussion itself and the very presence of two speakers representing regulators that, in the grand scheme, have a small purview over the American financial system, revealed how broad a reform is needed. As such, is any discussion that contains only the SEC and CFTC even relevant?

The SEC, staffed with just 3,700 regulators, for example, has very little authority over financial instruments that fall outside the more traditional definition. And, how does an agency such as the SEC both target run-of-the-mill insider trading and securities fraud while also tracking systemic risk in a complex financial system? The failure to bring down Bernard Madoff before it was too late shows how overextended the agency already is.

In the meantime, as Gensler aptly pointed out, the CFTC only regulates futures markets, missing the important and growing piece that is over-the-counter derivatives, among which are the many mortgage-backed securities that were at the heart of the sub-prime crisis. The two in combination have little effect on monitoring a financial system that is increasingly global and increasingly spread over a variety of financial instruments.

Export Opportunism - Part II

An update on President Obama's pledge to increase American exports - the president today made reference to the country's trade relationship with China, providing further evidence that the administration could take the route of pressuring China on the currency devaluation issue to address its trade imbalance, a move that the Chinese government will likely be less-than-thrilled about:

http://online.wsj.com/article/SB10001424052748704259304575043171767767724.html

A Bretton Woods Moment?

Sorry for my long absence from the elastic thinker. The demands of grad school have greatly weakened my brain's elasticity, and has rendered my gray matter into an examified/essayified amorphous pulp resembling baby food.

However, I recently contributed a post to The Morningside Post, a student-run newspaper/online blog at Columbia-SIPA, to re-whet your appetite!

http://themorningsidepost.com/2009/11/a-bretton-woods-moment/

Call centers to plowshares

In the last couple of weeks, new developments have shown that drought has severely impacted India's agricultural sector. But this has failed to grab major headlines until recently, when the situation became especially dire.

The situation should call attention to the still-pressing needs of India's farmers, who are less able to benefit from the economic expansion that has made India an emerging hub for call centers, software development and other "business processes." India largely remains an agricultural country - agriculture, forestry and fishing account for 17 percent of GDP - and should therefore promote the development in rural areas as much as it should focus on its "knowledge" sector, which generates more wealth and investment but also employs far fewer people.

Why bankers rule

In the past couple of days, much anger has arisen regarding bonuses paid to bankers on Wall Street or in the City of London among populist good-for-nothing welfare-state leeches like poor people and the uber-liberal-Sarah-Palin-hating "mainstream media" who, in between their worship of Barack Obama's statuette, find it so easy to bash anyone or anything that has a connection to financial services!

In an unusual effort to quell these outrageous attempts by all those pesky median-income or minimum-wage earners out there who can't get enough of taking a free ride off the hard work of rich people (all of whom got rich only by the virtues of hard work), the elastic thinker has decided to produce a list of 8 reasons why there is no problem paying out massive bonuses to bankers during an economic crisis that has produced unemployment of 9.5% (and rising):

1. Contrary to public opinion, bankers are actually the smartest people in the world. Unlike the money you earn, theirs requires $60,000/year MBAs, which means they're really, really smart. They actually earn their money, 'cause they figure out how to make money using other people's money.

2. Bankers work harder than you do. What? You want a bonus during a recession? Mortgage tough to pay? Well, bud, you shouldn't have bought that house. If you were smart enough to read that 10-K filing or actually turn on that Bloomberg terminal you have at home, you would've seen all this coming. What's that you say? You don't have a Bloomberg terminal? You snooze, you lose.

Again, that's why they get paid more than you, because they are actually smarter! Don't you know economics? Skill and its scarcity in the labor market are rewarded largely through compensation. That's why you make less, because you just couldn't make the cut.

3. Had Goldman Sachs and all the other God-affiliated institutions didn't pay bonuses, they couldn't attract such amazing talent! If they didn't pay bonuses, some other bank would find a few million to throw at them. That would risk a massive brain drain.

4. Bankers are prophets and decipherers of mysterious information that normal people simply are too incompetent to understand. I mean, come on, this is why one day the markets jump and the dollar gets stronger, and the next day the opposite happens based on new information. Let's leave figuring all that out to the bankers. They know best.

5. If it weren't for bankers, we would not have the movie "Wall Street," the actress Darryl Hannah, or the name Gordon Gecko in our vocabularies.

6. Bankers have more culture than you. They drive better cars, eat better food, wear better clothes, use BlackBerrys and go to better gyms than you. Not only that, they don't have to sit with the commoners at sporting events. They can get their caesar salad, Chardonnay and chicken fingers with dijon mustard dipping sauce in an air-conditioned box while you stand in line for 15 minutes to get your aluminum-foil-wrapped hot dog. Remember, perks like this are necessary to keep bankers happy. They are very busy people and need to relax every now and then to blow off some steam. Strip clubs help, too.

7. Bankers represent what the American economy's future is all about. Who needs to make useless widgets when you make knowledge?? It's the knowledge economy, baby!

8. Bankers are the backbone of America, generally speaking. When national challenges arise, they are the first to go to war ('we rate Halliburton a strong BUY'), show their patriotism (speculating on foreign currencies), and campaign for a cause ($240 million in lobby spending in election year '08!)!

Morally hazardous waste

As policymakers in the United States mull over new ways to regulate an ever-changing, ever-widening world financial landscape, it is important to create legislation that is not only reactive, but addresses the deeper issues of the structure of the increasingly concentrated American financial system.

Previous financial crises teach a valuable lesson - that moral hazard, or the willingness of market agents to take excessive risks with knowledge of a high likelihood of government crisis protection or intervention, is endogenous to world financial markets whether we like it or not. It's a matter of learning how to mitigate moral hazard, rather than eliminate it, that can help reduce that chances of future financial catastrophes. Most people, I think, would agree that the lessons from the current world meltdown will go largely ignored when (or if) boom times come around.

While new regulations are necessary, the Obama Administration must also look proactively at legislation passed during the last 15-20 years that have created a commercial banking sector that is, indeed, "too big to fail."

Nevermind the repeal of the Glass-Steagall Act, which once created a firewall between deposit-taking commercial banks and risk-taking investment banks - something that would have come in handy in the last few years. The Riegle-Neal Act was the most significant piece of legislation to deregulate commercial bank consolidation and provide an environment conducive to a deeper banking crisis. The Act relaxed regulations on the ability of banks to merge with other banks, leading to widespread banking mergers and the swallowing of smaller, usually state-chartered "relationship" banks into larger banks with national and international reach. The consequence was greater market concentration for the larger banks in markets nationwide.

The mergers of inefficient businesses into larger, more efficient ones in itself is not inconsistent with "economic efficiency." But when such businesses are crucial to the economy's systemic viability, such legislation should have been evaluated carefully. As banks consolidate and grow larger, a larger number of players becomes "too big to fail," leading to the impetus for larger bailouts and greater regulatory capture. In addition, when a large corporation such as Bank of America owns branches and takes in deposits in a wider range of geographies - mistakes made at the top of the corporation could have spillover effects in each of those markets where a BofA branch might be.

The Obama Administration may not wish to reverse the trend of bank consolidation - indeed, it is probably too late. But banks that have larger systemic importance should be held accountable for excessive risk-taking. A more stringent cap on market concentration would also be prudent to maintain the diversity of commrcial bank competition in markets nationwide.

The London G20 Summit gives IMF Massive Boost, but Circumvents Key Issues

The following is my coverage of the recent London G20 Summit. This was to appear in "Rationale," the LSE Economics Society's magazine, but from all indications the publication, which has a notoriously disorganized editorial staff, is several weeks behind schedule and may not even come to print. So I wanted to get this out so that at the very least, the three people who actually read this blog can see it and offer comments.

LONDON - British Prime Minister Gordon Brown has put the executioners on notice: send the West’s free-market policy orthodoxy to the gallows.

“The old Washington Consensus is over,” declared Brown, minutes after concluding contentious negotiations at the Group of Twenty (G20) Summit in East London on April 2. “Today we have reached a new consensus to take global action together.

“We have resolved that from today we will together manage the process of globalisation.”

Seizing on the symbolism of the first international summit since the American credit crunch spread its contagion worldwide, the British leader recognised the changing structure of world power – one in which one prominent leader can openly blame “blue-eyed, white” bankers for the global recession, for example, and another can openly challenge the U.S. dollar’s credibility with little backlash, denial or impunity.

But for all the sensational rhetoric surrounding the apparent decline of American capitalism, April’s meeting signaled the most sweeping expansion of the very organisation that has served as the Washington Consensus’s guiding light and lightning rod alike: the International Monetary Fund.

The G20 nations stopped short of reforming international finance on the scale of Bretton Woods, but still made a bold pledge of $1.1 trillion in new funds for the global economy to boost liquidity in a time of declining trade and growth.

As anticipated, at least $500 billion will go toward restocking the IMF’s financial war chest to $750 billion, making the Fund larger than the economies of four G20 member states. Japan, which already pledged $100 billion to the IMF in February, is joined by the European Union and China in providing $250 billion of this capital infusion.

The G20 have also pledged $250 billion to support trade finance. Another $250 billion in the IMF’s neutral currency, Special Drawing Rights (SDR), will be allocated to countries based on their IMF quotas to provide an extra buffer as trade declines. The multilateral development banks will also benefit from an additional $100 billion for additional lending.

At least $19 billion of the new SDR will be available to low-income countries, said IMF Managing Director Dominique Strauss-Kahn, and countries with surplus SDR will be able to sell them to other countries that have balance of payments or liquidity challenges.

“It is the beginning of increasing the role of the IMF not only as a lender of last resort, not only as a forecaster, not only as an adviser in economic policy in an old traditional role,” Strauss-Kahn said, “but also of providing liquidity to the world, which is the role…of a monetary institution like ours.”

The IMF expansion aside, the G20’s final communiqué also features stated commitments to continued monetary and fiscal expansion to the tune of $5 trillion worldwide by the end of 2010, adoption of new global financial regulations, and protecting international trade and development.

The six-point agreement from the G20 communiqué, as laid out by Brown:
· Set new principles for the global banking system: bring shadow banking system, i.e. hedge funds, into regulatory framework; improve accounting standards; provide oversight of credit ratings agencies; and “name and shame” non-compliant jurisdictions that serve as tax havens. Part of this will entail the creation of “colleges” of regulatory agencies and the creation of the Financial Stability Board to report on developments in global financial markets.
· Clean up banks’ toxic assets through a common global approach.
· Collectively implement $5 trillion in macroeconomic stimulus by end of 2010; pledge central banks to monetary expansion; infuse capital into IMF for increase global liquidity and crisis response capacity.
· Continue to strive for poverty reduction through Bretton Woods institutions, necessitating increased accountability, transparency and fair representation of developing countries in these institutions’ governance; heads of staff should be appointed through a competitive, merit-based selection process.
· Protection of trade, 90 percent of which depends on finance; and a pledge of $250 billion in trade finance and additional funds through multilateral development banks.
· Promotion low-carbon growth and a move toward creating a post-2012 worldwide climate change regime.

Sir Nicholas Bayne, a former top economic diplomat with the British Foreign and Commonwealth Office and lecturer at the London School of Economics and Political Science, said the summit was a success in that delegations were ready to work together and put their main focus on aiding countries in the most difficulty with capital boosts for the IMF.

“But the key point will be to get the promised sums delivered,” Bayne said.

Just as significant as the results of the summit is what was noticeably absent from the communiqué. The G20 agreement lacked teeth on several specific issues such as climate change, specific financial regulations, and politically charged issues such as exchange rate policies and over-consumption in the United States, phenomena that may have helped produce unsustainable financial bubbles.

Ed Miliband, the British government’s climate change and energy secretary, said the G20 summit was a good opportunity to begin deliberations on climate change, but admitted there is another forum for that issue.

“The G20 shows that there is an understanding among world leaders that the world economic crisis and climate crisis can be solved together,” Miliband said. “It is promising but challenging to get an ambitious climate agreement. There are frameworks for climate change discussions (such as the United Nations) and we need to respect that.”

‘The IMF is Back’
U.S. President Barack Obama may have been the last leader to take the press limelight following the summit, but the IMF – which not long ago was fighting futility - was the real star.

“Maybe some of you were in the IMF press conference at the end of the annual meeting last October,” a beaming Strauss-Kahn said. “Some of you may remember what I said at this time was the IMF is back. Today, you get the proof.”

The massive expansion of the IMF’s coffers also enhances its role as forecaster and monitor of international economic developments. The progress of the G20’s initiatives will be measured against IMF projections and forecasts, building a stronger case for economic information to flow through the Fund’s research department.

“I’m really happy to be the head of an institution, which more than year ago in Davos, asked for a global stimulus,” Strauss-Kahn said. “Nobody, no other institution, was able to see that the crisis would be so deep that we would need a global stimulus. We asked for that and we have been followed.”

With the IMF’s expanded role, the complexion of the world’s response to the global economic crisis will have a distinct IMF flavour. The United States, unable to extract pledges of additional fiscal stimulus from skeptical France and Germany, must now look to the IMF as its last instrument of economic power during the crisis.

A less-publicised but equally powerful prong of the IMF’s post-G20 response will be the expansion of its new Flexible Credit Line, which does little to hack away at Washington Consensus orthodoxy and in some sense reinforces it.

The FCL is intended to provide “pre-conditional, precautionary” IMF financing to countries with “good” IMF track records, which would include countries that successfully implemented IMF adjustment policies and have a history of successful repayment of IMF loans. Mexico recently became the first country to take advantage of the FCL, gaining access to $47 billion in IMF credit.

In one attempt to balance its growth while enhancing its accountability and transparency, the Fund will also end a longstanding, informal tradition of elevating a European to manage the Fund. Now, as the communiqué points out, IMF staff will be selected through a competitive, merit-based process.

The G20 also agreed to accelerate reform of the IMF quotas that determines how much of a voting share a country may have on directing IMF programmes.

A review on the realignment of IMF quotas, which currently give the United States an effective veto with 17 percent of the vote (85 percent majority is needed to pass an IMF package), will now be due in 2011 rather than 2013.

“They are right to say quotas need to be changed but there is a timetable for that,” Brown said.

The IMF stopped short of recommending a transition away from the U.S. dollar as the world’s reserve currency, although Strauss-Kahn stressed the “symbolic” value of the SDR allocation. Prime Minister Brown denied there is any threat to the existing monetary order, especially considering recent renewal by China and Russia of time-old criticisms that the United States is an irresponsible custodian of the world’s reserve currency.

“Issues about international currency have not led to detailed proposals from anyone,” Prime Minister Brown told reporters.

The U.S. veto at the IMF will therefore remain during these crucial years of IMF expansion. The Washington establishment and its policy consensus likely still hold the keys to the car.

“The IMF is also back as a policymaker,” Strauss-Kahn said. “I’m not saying the different governments of the G20 are going to do all the time what we think is the right thing to do, but at least we are the partner to discuss with and analyse what kind of policy should be implemented.”

The American Chastening

On a day meant for concrete solutions to a rapidly spreading economic crisis, there was no shortage of symbolism and cynicism as new global powers came to the world stage.

On the morning of the summit, a journalist representing a Saudi newspaper put it this way.

"The world's problems will be saved all in a building that is owned by the Emirates," he said with a smirk, referring to ExCeL London, the East London Docklands convention centre owned by the Abu Dhabi National Exhibitions Company.

Even the London Summit logo indicates a shift in political and economic power. It depicts the earth and sun shining brilliantly along its arc. Europe is on the verge of rotating into the darkness of night, joining its friends in the United States, while a beacon of light emerges from the East. “Stability, Growth, Jobs” is the tagline.

And the U.S. president, known for his talents with the spoken word, was also battling a cough and cold that brought his normally rousing speeches down to earth, much the same way his country’s financial sector has been stricken by infectious leverage and toxic assets. Ultimately, President Obama was left atoning for the alleged sins of Wall Street, which are partly to blame for a crisis that will drop world GDP growth between 0.5 and 1 percent in 2009, according to the IMF.

“We exercise our leadership best when we are listening, when we lead by example and show some element of humility,” Obama told reporters.

“There were occasional comments [by other delegations], usually wedged into some other topic that indicated from their perspective that this started in America or this started on Wall Street, or this started with particular banks or companies,” he added. “Perhaps what helped was my willingness to acknowledge that - and it's hard to deny - that some of this contagion did start on Wall Street.”

While the summit revealed a new global economic landscape, it by no means created a permanent transformational shift. The United States and United Kingdom had considerable bargaining power during the summit, and used the fact that the summit was limited to one day of discussions to create pressure for parties to come to agreement. British officials reflected to that sentiment as they assured the media that G20 delegates would nail down an agreement.

“I don’t think we’ll get that many people back around the table soon so we’ve got to take action today,” said Lord Peter Mandelson, British business secretary, hours before G20 leaders were to emerge from the discussion room.

“There is some lively discussion but we are going to reach an agreement today,” added Stephen Timms, Labour Member of Parliament for East Ham and financial secretary to the Treasury. “Everybody recognises that we need to deliver.”

The Saudi reporter, who was less impressed than most by Obama’s international popularity, predicted the summit would be about the United States and its allies pushing creditor countries to finance fiscal expansion in the United States and elsewhere.

“I think it is the sort of thing where Saudi Arabia, Japan and China will be told, ‘look, you have to pay up,’” he said.

Bayne said there is more coordination between non-G8 participants on forming policy than is usually reported, but he added that countries may not be ready to assert themselves in the G20 environment.

“So far this has not led to major initiatives in the G20 or elsewhere,” he said. “They are biding their time and testing the water. China's reserve currency idea is a first indicator. More may surface when Korea takes over the G20 chair in 2010.”

What Comes Next

The lessons of the past and present may show that international cooperation is crucial to solving global economic crises. But just as important is the legitimacy of the organisation shepherding such cooperation.

President Obama has garnered praise from allies such as Turkey and Mexico for reaching out to the developing world. But as the G8 prepares to meet in Italy in July and the G20 again in Pittsburgh in September, other nations are justifiably concerned that they are yet again confined to the backseat of global decision making.

As pointed out by Daniele Archibugi, a research director at the Italian National Research Council in Rome, the G20 represents 85 percent of global GDP but also includes only one country from Africa. Spain and the Netherlands have greater GDP than Saudi Arabia and Argentina, and while the former were invited to the G20, they are not officially included in the G20 while the latter two are. Countries with large populations but small aggregate economies, such as Bangladesh, do not even receive invitations to the summits that determine so much of their future.

“The inability of the G20 to come up with solutions is largely dependent on its institutional nature,” Archibugi wrote in The Guardian on March 28. “In a world that demands greater accountability in world politics it is inconceivable that everyman's problems should be addressed in summits held outside the confines of democratic logic.”

Bayne said the G8 is not necessarily obsolete. While the G20 has been engaged primarily with financial and macroeconomic issues, the G8 has a much broader scope of issue areas to work on.

“If the G8 can effectively co-opt the leading emerging markets they can still play an effective agenda-setting and initiatory role,” he said. “The Japanese chair did not do this in 2008, for fear of China. Italy this year and Canada next year may do better.”

Strauss-Kahn and Obama also endorsed an increasingly multilateral approach to the economic crisis response, but it remains unclear how this will be put into practice before the next major institutional reform, the 2011 IMF quota review, comes through.

"Last time you saw the entire international architecture being remade," Obama said of the Bretton Woods meetings following World War II. “Well, if there's just Roosevelt and Churchill sitting in a room with a brandy, that's an easier negotiation. But that's not the world we live in, and it shouldn't be the world that we live in.”

Strauss-Kahn said extending the G20 to be G24 or G25 with the addition of several “low-income countries” would provide an accurate representation of the world economy.

“Everybody has their own recipe – there was 12, then 13, 14, 15 and finally it has been the G20,” Strauss-Kahn said. “If we really want the G20 to be a body of governance of globalisation, then we certainly need the G20 to be increased to include some country representatives of the low-income countries.”

The rest of the world, still declining into recession, may not be able to wait that long. **


You can view the G20 communique at http://www.londonsummit.gov.uk/en/summitaims/summit-communique.

The G20’s Specific Plans for Strengthening the International Financial System: http://www.londonsummit.gov.uk/resources/en/PDF/annex-strengthening-fin-sysm.

IMF Resources and the G20 Summit: http://www.imf.org/external/np/exr/faq/sdrfaqs.htm.

G-20 Wrapped Up

Just got out of President Obama's press conference, which effectively concluded the major proceedings of today's G-20 summit. The president was clearly the main event, and used it as an opportunity to reassert American leadership - his press conference was not only significantly longer than that of Summit host Gordon Brown, but his was the last to finish it off.

The G-20 established a communique, some of it specific, most of it broad, to address the financial crisis. The highlight is the effective tripling of the International Monetary Fund's resources thanks to Japan, the European Union, and other unnamed donors -- it is unclear how much China or Saudi Arabia have provided, but it's likely they're a big part of it. In the words of IMF Managing Director Dominique Strauss-Kahn, "the IMF is back."

Partially due to recent economic data but also because of the apparent success of the Summit, stock markets in Japan, Europe, London and the United States rallied. Is this the end of the crisis? Will this improve confidence in the world economy? And will this help the poorest in the world?

This writer is skeptical. The Communique as such lacked meat on several key issues such as climate change, poverty reduction and corporate governance - it will be interesting to see if the 20 governments involved also will be to ratify or enact key parts of the deal. Agreeing to agree may not be enough.

Arriving at the G20

The day has arrived, when leaders representing the world's 20 most powerful economies will solve the world economy's problems between lunch and tea time in a single day.

On the second bus from the media accreditation and security site to the ExCel Center, a journalist for a Saudi newspaper gave me his frank assessment of the Summit, as seen through the Arab perspective, especially given that the ExCel convention center in London is owned by the same company as Emirates.

"The world's problems will be saved all in a building that is owned by the Saudis," he smirked.

Ok, so time to figure out how this media circus works. I couldn't find a workstation with a plugin because, well, I'm a bit low on the totem pole. So I'm using the free wireless and hope to grab some free food in a bit. Most of the press conferences are accessible to pool photographers and reporters, so I hopefully will at least get to sit in on the final press conference at the end of the day.

Greenspan makes his case...again

I'm not even going to try to make a claim I have the slightest lick of economic expertise in comparison with former Federal Reserve Chairman Alan Greenspan, but I disagree with his latest defense that the persistently low federal funds rate - the Fed's short-term, benchmark interest rate - had nothing to do with the historically low, long-term mortgage interest rates that are blamed for contributing to a massive, unsustainable and unchecked expansion of housing credit.

Over-saving in growing Asian countries led to an excess of capital, which, after being reinvested in the United States and other economies to finance our deficits, pushed downward on long-term interest rates, he writes.

Greenspan does not mention that when interest rates are low, and banks can borrow from the Fed at dirt cheap prices, the ability to capture even higher profit margins sends banks looking for the high-priced goods, sub-prime mortgages and the like - at the very least, to beat inflation. The ability to get easy money in the short-term has spillover effects for the short and long term.

Mortgage rates may have been decoupled from short-term interest rate fluctuations as Greenspan contends, but don't low short-term rates spur inflationary growth and perhaps make people more confident about the economy and more willing to shell out cash for a long-term, debt-financed investment such as a home? The short-term and long-term may not be directly correlated, but doesn't the former impact a consumer's willingness to take risks in the latter?

He also neglects to mention the impact of short-term interest rates on the ability for banks to multiply money supply and expand other shorter-term vehicles of credit, from car loans to credit cards. This expansion drove up consumption to levels that, as we now see, were highly overblown (just look at how much the economy has receded without such free availability of cheap credit).

Finally, he barely mentions the Fed's utter inability to regulate banks' mortgage-lending practices. The crisis was as much a regulatory policy failure as much as it was a market failure.

Nevertheless, it may be difficult to pin the crisis on any one person or institution. The moral of the story probably is that the crisis is not Greenspan's or the Fed's fault, but that persistently low interest rates helped create a credit bubble - and the housing market was the first bubble to go bust.

The Most Trusted Name in Pseudo-News

It made for good comedy on "The Daily Show," but Jon Stewart's awe-inspiring, go-get-'em tirade against CNBC points to a larger, serious issue of integrity in the most important vein of the news media at the moment: the financial press.

Information is the lifeblood of efficient financial markets, and as a primary relayer of market-sensitive information, networks like CNBC have, above all, a journalistic responsibility to provide no-spin, accurate information on the daily intricacies of the world of finance, a world constantly in flux. CNBC's constant forward-looking, speculative, CEO-cheerleading, Wall Street-friendly analyses of economic policies before and since the outset of the crisis send a flagrantly incorrect impression to the American public that government policy can and will be effective only if it passes a Dow Jones Industrials Average litmus test - the up or down movement of the DJIA - and that government policy can only be effective if Wall Street thinks so. In any case, the current financial crisis and resulting government bailouts should be enough evidence that Wall Street does not always have the public's interest at heart).

Because CNBC, The Wall Street Journal, and other specialist business news outlets are now watched and read by more members of the average American public than ever before, the corporations that own these outlets are under pressure to "dumb down" business news. The result has been networks like CNBC moving toward the mainstream cable news model of opinionated talking heads running "news" shows at the expense of the boring, mundane, intricate, black-white-AND-gray, dynamic thing people used to call, "journalism."

This is unethical and too dangerous a risk when the investments of pensioners, workers, parents and others are on the line.

Transatlantic handshake, Day 2

UK Prime Minister Gordon Brown topped off his visit to the U.S. with a speech to a full Congress Wednesday to promote his "Partnership of Purpose" with the United States. In a gracious, laudatory and often deferential-to-the-U.S. speech, the PM was forthcoming and direct in his support of the American hegemony and its new chief, President Barack Obama.

In his speech, Mr. Brown also issued a sharp rebuke to the George W. Bush Administration, saying "this is the most pro-American Europe in living memory," suggesting that the U.S.' obvious inability to cooperate with European allies in recent years was not because of ideological differences but because of how the pre-Obama occupant of the Oval Office managed relations with Europe.

For one, Brown looked re-energized, despite the stagnation of his political agenda at home. He appears to be truly renewed by having a trans-Atlantic partner in President Obama with whom there can finally be a dialogue between the UK and US based on respect, debate and exchange of information. He was clearly basking in the limelight.

Mr. Brown's stated objectives on issues such as "expanding scientific research" and eliminating abject poverty around the world are admirable, but there is, with good reason, some skepticism about Mr. Brown's commitment to such policies -- for example, how can a government that wants to help lead the fight against climate change also build a third runway at Europe's busiest hub airport instead of upgrading London's 19th-century public transportation system or investing in newer, more efficient modes of inter-city mass transit?

Some other highlights:
-- Sen. Edward M. Kennedy, the "lion of the Senate," is now SIR Edward Kennedy, thanks to Queen Elizabeth II.
--"A worldwide reduction in interests rates" is needed because the UK and US can't do it alone. This is a sign that the economy's real bad and is going to get much worse. The Bank of England's benchmark rate is already down to a meager 0.5% ("who wants money for free?") and the Fed's federal funds rate is less than that.
-- The Republican side of the house was often slow to applaud to Mr. Brown's proposals. Mr. Brown's stated agenda mirrors that of his American counterpart, and the fissure in Congress is obvious. At one point, when the prime minister attacked offshore tax havens, it took the Republican side of the aisle a good 5 seconds to start applauding (simply out of respect to the Right Honourable guest and not out of agreement).

A view from Mexico...

Yesterday I attended one of the more interesting lectures I've encountered here in London, a frank discussion with Jesús Silva Herzog, the former finance minister of Mexico (during the 1982 debt crisis, no less), among other things. Here are some highlights from his talk Monday evening:

(1) Mr. Silva Herzog sharply criticized neo-liberal orthodoxy, saying it has prevented Mexico's government from promoting full employment and economic development. He pointed to the escalating debt-to-GDP ratios of many industrialized countries (think U.S. and U.K.) as reason for why Mexico should allow its debt ceiling to increase slightly if it means preventing a total economic collapse.

(2) On the financial crisis - "We've been through it before, so a 2 percent drop in GDP [which has been projected] is not that bad." He expected Mexico, 80% of whose exports go the contracting United States economy, to suffer in 2010 as well. "This crisis is not a liquidity problem, it is about solvency."

(3) The banking sector - One of the main areas of vulnerability that Mexico has during the financial crisis is the opening of its well-capitalized, healthy banking sector to foreign ownership. For example, Banamex is owned by the ailing Citigroup. Further complicating this is that if the U.S. government takes a 30-40% stake in Citigroup as planned, that would break Mexican law, which bars any foreign government for owning a stake in domestic banks.

Liberalization of the Mexican banking sector (which was a bone of contention during NAFTA negotiations in 1993), was one of the greatest mistakes Mexico has made, he said. Mexico is the only G/20 country that has allowed such deep, widespread ownership of domestic commercial banks. The threat of foreign banks repatriating capital for their own survival in their home countries is an omnipresent threat Mexican officials must consider.

(4) On aid from the United States to fight crime related to the drug trade - "it's nothing. It's more of a symbolic thing, that the U.S. is helping us fight the drug cartels." He used this point to stress that unemployment, particularly in the maquiladores in the northern cities near the U.S. border, could help fan the flames of the drug trade.

(5) On Latin American unity - Mr. Silva Herzog said Latin American unity has been difficult to find during the financial crisis because of the lack of synchronicity. Unlike the Euro zone countries, which more or less share the same business cycle (a big reason why the Eurozone has been a strong monetary union), Latin American countries experience differing business cycles.

He was also a little bit of a comedian, at times cutting through serious topics with a little bit of humor. Like when he said Mexico needs to once again take the lead among Latin American countries (a role Brazil has now assumed), especially at the G/20 summit in London next month. He suggested the three Latin American representatives in the G/20 meet somewhere in South America or in Madrid, across the Atlantic, "and I don't mean in the middle of the Atlantic."

Pay to Play?

In his speech to a fully assembled Congress Tuesday night, President Barack Obama spoke of Leonard Abess, a Miami bank executive who, upon departing his job, received a massive separation bonus. Instead of pocketing it all, however, Mr. Abess shared it with the hundreds of people who work and used to work for him.

There's no doubt this was a great act of kindness, but was Mr. Abess's prominent placement in the new president's first "state of the nation" address a result of his political loyalty over the years?

It turns out Mr. Abess is a significant donor to the Democratic Party, amassing $25,000 in "soft money" contributions on top of more than $137,400 political contributions, according to a search of Federal Election Commission records. Try the query here.

Not sure this is anything to cry about, but in this age of cynicism about politics, it's hard not to think that he got props in a major national speech as some sort of reward for his financial support of (mostly) Democratic candidates - although he did contribute to George W. Bush's re-election campaign.

Enough Said...

I need not write anything more, other than to quote one of President Obama's responses to a reporter at his first primetime news conference as head honcho:

"When it comes to how we approach the issue of fiscal responsibility, again, it's a little hard for me to take criticism from folks, about this recovery package, after they presided over a doubling of the national debt. I'm not sure they have a lot of credibility when it comes to fiscal responsibility."

I'd like to thank the prez for finally pulling a little punch on the obstructionist senators who are dragging their feet. It's not quite a knockout uppercut, but a slight jab from the Illinois southpaw.

Transparency or "Obama 2012"?

Today I received an e-mail addressed from David Plouffe, President Obama's campaign manager, on behalf of BarackObama.com. He asks me to watch a YouTube clip of the president's nationally televised plea for Americans to support his economic recovery plan. An abbreviated screen shot of the e-mail:


Note that it is signed by Mr. Plouffe, as Mr. Obama's campaign manager. So, what exactly is Mr. Plouffe's role in the Obama Administration? Obviously, having engineered one of the most effective (and expensive) presidential campaigns ever, Mr. Plouffe undoubtedly has won the president's loyalty. But with such an e-mail, who is Mr. Plouffe representing (especially when, at the e-mail's end, a statement reads that it was paid for by the Democratic National Committee)?

Ultimately, I think this e-mail is fairly innocuous - and it reveals the president's desire to communicate directly with constituents (or those who signed up to an e-mail list) in a direct, seemingly transparent fashion - but is this e-mail an item of electioneering? Or is it the president communicating with his constituency? I think Mr. Obama should be careful in such messages, as they could be construed as an ongoing re-election project, rather than factual communication on public policies currently being debated.

Time for the Dems to Grow a Pair

The honeymoon of the Barack Obama presidency lasted about as long as a Britney Spears nuptial. As America got back to business after the euphoric day of January 20, several large corporations announced layoffs, unemployment claims rose, the GDP shrank, and Citigroup held off (at least for now) its plans to buy a multi-million dollar corporate jet. These are just a few of the ridiculous headlines to remind us that, yet again, the little guy pays while the big-wigs suffer minor setbacks (the folks at Merrill Lynch might afford only one vacation to southern France, instead of three).

Mr. Obama's approach to the economy has, in my view, sent mixed signals. First, his recently-confirmed Treasury secretary (Timothy Geithner) irresponsibly sounded the battle cry of a trade war with China, outwardly stating the obvious but unspeakable - that China manipulates its currency to boost its export-drive economy (at the expense of American industry). This, ironically, before the passage of a massive spending bill that will need to be financed entirely by parties other than the debt-ridden U.S. government, namely the Chinese central bank. Not to mention the even more devastating consequences to China's economy if it were to revalue its currency further, an event that is not in anyone's best interest and least of all China's biggest trading partner, the United States. Japan is already hitting a wall with the yen at its strongest level in years.

On the domestic front, we have quickly found out that Mr. Obama's admired approach to building consensus may not be a match for the intensity of the current economic crisis and the political fault lines that have become clear this week. We need not look further than the fact that the House of Representatives passed President Obama's $819 billion stimulus bill without a single Republican supporter.

So what does all this mean? I respect Mr. Obama's desire to hear both sides of the issue, but ultimately, he is the boss that the American people elected. Somehow, the Democrats have such an inferiority complex and manage to bungle even those times when they have unequivocal legislative power - it is time to create the policies that the American people overwhelmingly demanded in the November election, not watered down, ineffective policies that attempt to bridge some sort of political chasm. It's time to ignore Republican obstructionism and faux consensus building and play hard, cold politics, if Mr. Obama is to get anything done for the economy in a swift manner. And I have faith that he will.